Capital Inflows, Exchange Rate Flexibility, and Credit Booms

24 Pages Posted: 28 Feb 2012

See all articles by Nicolás E. Magud

Nicolás E. Magud

International Monetary Fund (IMF)

Carmen M. Reinhart

Peter G. Peterson Institute for International Economics; National Bureau of Economic Research (NBER)

Esteban Vesperoni

International Monetary Fund (IMF); University of Maryland, College Park

Multiple version iconThere are 3 versions of this paper

Date Written: February 2012

Abstract

The prospects of expansionary monetary policies in the advanced countries for the foreseeable future have renewed the debate over policy options to cope with large capital inflows that are, at least partly, driven by low interest rates in the financial centers. Historically, capital flow bonanzas have often fueled sharp credit expansions in advanced and emerging market economies alike. Focusing primarily on emerging markets, we analyze the impact of exchange rate flexibility on credit markets during periods of large capital inflows. We show that bank credit grows more rapidly and its composition tilts to foreign currency in economies with less flexible exchange rate regimes, and that these results are not explained entirely by the fact that the latter attract more capital inflows than economies with more flexible regimes. Our findings thus suggest countries with less flexible exchange rate regimes may stand to benefit the most from regulatory policies that reduce banks' incentives to tap external markets and to lend/borrow in foreign currency; these policies include marginal reserve requirements on foreign lending, currency-dependent liquidity requirements, and higher capital requirement and/or dynamic provisioning on foreign exchange loans.

Keywords: Exchange Rate Flexibility, Domestic Credit, Foreign Currency Loans, Capital Inflows, Financial Regulation, Bank Credit, Capital Flows, Credit Expansion, Exchange Rate Regimes, Flexible Exchange Rates

JEL Classification: E44, E52, F33, F34

Suggested Citation

Magud, Nicolas E. and Reinhart, Carmen M. and Vesperoni, Esteban Rodrigo, Capital Inflows, Exchange Rate Flexibility, and Credit Booms (February 2012). IMF Working Paper No. NO.12/41. Available at SSRN: https://ssrn.com/abstract=2012226

Nicolas E. Magud

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Carmen M. Reinhart

Peter G. Peterson Institute for International Economics ( email )

1750 Massachusetts Avenue, NW
Washington, DC 20036
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Esteban Rodrigo Vesperoni

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

University of Maryland, College Park ( email )

College Park, MD 20742
United States

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